The level at which the lifetime allowance tax charge bites is being reduced.
Applying for fixed protection before 6 April 2012 will freeze the limit with a potential tax saving of £165,000.
In 2009 the previous Government announced its intention to restrict the value of tax relief on pension savings with effect from 6 April 2011 for people with 'gross income' of £150,000 or more.
The current Government decided on a different course, which included a reduction to the annual and lifetime allowances, which respectively restrict the tax relief on pension savings in any one tax year, and impose a tax charge where the total value of pension savings, when drawn or at age 75, exceed a certain limit.
Annual allowance (from 6 April 2011)
There is no limit on the contributions that can be paid to a pension scheme, but there is a limit on the contributions qualifying for tax relief. The limit on the amount paid or rights accrued in a tax year into a registered pension scheme is known as the annual allowance.
From April 2011 the annual allowance for tax-privileged saving reduced from £255,000 to £50,000.
Care must be taken as the pension saving is based the total amount invested in the scheme year. This amount may be different to the amount invested in the fiscal year to 5th April.
Lifetime allowance (from 6 April 2012)
In addition the lifetime allowance (LTA) is to be reduced from £1.8m to £1.5m from 6 April 2012.
The LTA is important because the value of grossed up pensions and/or lump sums taken, which are in excess of the LTA are subject to a tax charge.
The rate of the LTA charge depends on how benefits are taken and are as follows:
- any amount over the LTA which is taken as a lump sum is taxable at 55%;
- any amount over the LTA which is taken as a taxable pension is taxable at 25%.
Reducing the LTA exposes a greater number of people to a tax charge on their pension savings. To mitigate the immediate direct effect of the change it is possible to apply for 'fixed protection'.
If the value of pension savings is expected to be more than £1.5m when benefits are taken on or after 6 April 2012, an application can be made for 'fixed protection'.
Where 'fixed protection' is obtained the LTA will remain at £1.8m rather than the reduced standard LTA of £1.5m. It will remain at this £1.8m level until such time as the standard LTA rises above £1.8m, at which stage fixed protection stops and the LTA becomes the higher standard LTA.
To continue to benefit from the £1.8m limit, an application needs to be lodged with HM Revenue & Customs (HMRC) by 5 April 2012 and certain conditions must also be met.
Failure to take action might result in a tax liability of 55% on any excess fund over the applicable LTA. In an extreme example, someone with a fund of £1.8m, vesting after 5 April 2012, might find themselves with an unnecessary tax liability of £165,000 (£300,000 x 55%).
Fixed protection conditions
The conditions for fixed protection are that the individual:
- cannot start a new arrangement other than to accept a transfer of existing pension rights;
- cannot have a payment into money purchase arrangement (except for National Insurance rebates);
- cannot accrue rights in a defined benefit arrangement by more than the 'relevant percentage'; and
- will be subject to restrictions on where and how they can transfer benefits.
If any of the conditions are breached fixed protection is lost and the individual is obliged to notify HMRC and their LTA drops to the standard LTA.
Application can be made up until 5 April 2012 with no scope for late applications.
Note that to apply for fixed protection the current value of pension rights does not need to be over £1.5m. Whether to apply for fixed protection will depend on a number of factors. Fund size is the most obvious of these, but account needs to be taken of the anticipated timing of taking benefits and expected future investment returns.
Where the current total value of pension rights is near or over £1.5m, making an application for fixed protection will be obvious, but what of the situation with someone in their mid-50s with a pension pot of £1.2m planning to retire at 60?
If the growth projections do not materialise as expected and the anticipated value of the pension pot at retirement falls below the standard LTA, pension contributions can be restarted. Fixed protection would cease to apply and the value of benefits drawn would be matched against the standard LTA.
Existing primary or enhanced protection in place
Fixed protection is not available to those with enhanced or primary protection which became available in April 2006.
While enhanced protection applies there is no LTA charge if pension saving is more than the LTA. This means that while someone has enhanced protection they will not be affected by the reduction in the LTA.
With primary protection the amount of protection increased in line with the normal LTA based on one's personal uplift factor. With the standard LTA being reduced to £1.5m the amount of primary protection will be based on a set allowance of £1.8 million, whilst that remains higher than the standard LTA.
What this means is that the personal LTA under primary protection is not reduced but is frozen until such time as the standard LTA exceeds £1.8m.
- Review current and projected pension savings values.
- Consider maximising pension contributions this year, taking care with timings in relation to scheme year ends.
- Where appropriate, make an application for 'fixed protection' before 5 April 2012 and take steps to ensure all pension contributions cease or rights accruing fall within the allowed limits.
- Possibly take benefits earlier to ensure the LTA is not breached.
There is no 'one size fits all' as to whether to apply for fixed protection and the decision will depend on a number of factors.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.